Dollar at 13-month high vs. euro

Pound continues decline amid interest-rate speculation

By

WanfengZhou

NEW YORK (MarketWatch) - The dollar soared to a 13-month high against the euro and a nine-month peak versus the yen Friday, as a strong manufacturing report buttressed the sentiment that the U.S. economy is continuing to outperform Europe and Japan.

In a light trading session ahead of the holiday weekend, the euro tumbled 1.1% to $1.1951. The currency dipped to as low as $1.1938 earlier in the session, the weakest level since May 2004.

The dollar gained significant ground after the Institute for Supply Management reported earlier Friday that U.S. manufacturing grew at a faster pace in June while price pressures eased.

The ISM index rose to a higher-than-expected 53.8% in June from 51.4% in May. Prices paid fell to 50.5% from 58.0% in May, the lowest since February 2002. See full story.

Readings over 50% indicate expansion. The ISM has been above 50% for 25 straight months.

"This was a very solid report on the U.S. manufacturing sector and certainly supports the comments from the Fed yesterday that they're likely to continue pushing the fed funds rate higher through the rest of the year and perhaps into 2006," said Bob Sinche, head of global FX strategy at Bank of America.

Sinche said data like this will likely prompt the market to revise up expectations for rate hikes. The market is generally expecting the fed funds rate to move up to 4%.

Ronald Simpson, an analyst at Action Economics, said the relatively better growth rate and aggressive interest rate policy in the U.S., along with the continued speculation of a rate-cut in the euro-zone, will continue to push the dollar higher in the near-term.

The Fed raised its target lending rate to 3.25% from 3% and left the door open for more. The committee slightly modified its assessment of the economy from the May statement, reflecting recent moderate inflation data and a more upbeat outlook for the economy. See full story.

On the Japanese front, a stronger-than-expected reading for a leading Bank of Japan business confidence index couldn't help the yen, which approached a nine-month low against the dollar on Friday.

"The recent strength caught some dollar bears by surprise as they were clinging onto unsubstantiated hopes that a 'helping hand' would protect the 110 level and the Tankan report did not make much of a difference," said analysts at Deutsche Bank.

But the yen has suffered in recent sessions as the high price of oil is seen as a risk to Japan's export sector should global consumer spending be lost to rising energy bills.

The dollar was last up 1% at 111.74 yen.

In Europe, the euro did find some early support from stronger-than-expected manufacturing purchasing managers indexes throughout Europe, but that support was quickly eroded during the U.S. session.

Meanwhile, political uncertainty continues in the euro zone.

On Friday, German Chancellor Gerhard Schroeder lost a vote of confidence in the Bundestag Friday, triggering the possibility of early elections in the fall.

Schroeder himself called for the vote to speed up the elections, a move that is likely to be challenged in constitutional court. See full story.

Schroeder has seen his popularity fall in recent years because of high unemployment and unpopular reforms planned for welfare and labor benefits.

German shares have risen on hopes for a win by the opposition Christian Democrats, who are considered more business-friendly.

The currency under the most pressure continued to be the British pound.

It's dropped to multi-month lows on expectations of narrowing interest-rate differentials between the U.K., which currently has its key rate at 4.75%, and the U.S., where the Federal Reserve's target now stands at 3.25%.

Sterling has fallen since the minutes from a Bank of England meeting published earlier this week showed two members favoring a rate cut.

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